Knowles Corporation

At this time, I'd like to welcome everyone to the Knowles Corporation third quarter 2024 earnings conference call. Please note that this call is being recorded. At this time, all participants are in a listen-only mode. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question, please press star followed by the number one on your telephone keypad. To withdraw your question, press star one a second time. I will now turn the call over to Sarah Cook.

Thank you, and welcome to our third quarter 2024 earnings call. I'm Sarah Cook, Vice President of Investor Relations, and presenting with me today are Jeffrey New, our President and CEO, and John Anderson, our Senior Vice President and CFO. Our call today will include remarks about future expectations, plans, and prospects for NOLS, which constitute forward-looking statements for purposes of the safe harbor provisions under applicable federal security laws. Forward-looking statements in this call will include comments about demand for company products, anticipated trends in company sales, expenses, and profits, and involve a number of risks and uncertainties that could cause actual results to differ materially from current expectations. The company urges investors to review the risks and uncertainties in the company's SEC filings, including, but not limited to, the annual report on Form 10-K for the fiscal year ended December 31, 2023, periodic reports filed from time to time with the SEC, and the risks and uncertainties identified in today's earnings release. All forward-looking statements are made as of the date of this call, and Knowles disclaims any duty to update such statements except as required by law. In addition, pursuant to Reg G, any non-GAAP financial measures referenced during today's conference call can be found in our press release, posted on our website at Knowles.com, and in our current report on Form 8K filed today with the SEC. This will include a reconciliation to the most directly comparable GAAP measure. All financial references on this call will be in a non-GAAP continuing operations basis unless otherwise indicated. We've made selected financial information available in webcast slides, which can be found in the investor relations section of our website. With that, let me turn the call over to Jeff, who will provide details on our results.

Thanks, Sarah, and thanks to all of you for joining us today. Before I move on to the results in detail, I would like to remind you that all financial metrics given on today's call are on a continued operations basis unless otherwise noted, as we signed a definitive agreement in Q3 to sell the consumer MEMS microphone business. The sale will further our strategy of transitioning the company's portfolio to higher growth markets and products where we have high differentiated solutions that drive value for both our customers and shareholders. This positions NOLs for strong growth in both revenue and earnings in the future. As demonstrated by our third quarter results, our total company adjusted EBITDA margins were 24.6%, and as market conditions improved in the PD segment and we realized the full benefit of synergies from the Cornell acquisition, I expect additional margin expansion. Now turning to our results. We continue to deliver on expectations in the third quarter. Revenue of $143 million was at the high end of our guided range, which represents 32% growth on a year-over-year basis, driven by the Cornell acquisition, along with 4% organic growth. EPS of 26 was at the midpoint of our guided range, while cash from operations was $53 million, inclusive of CMM, exceeding the high end of our guided range. On to our segment. In Q3, MedTech specialty audio revenue grew 4% sequentially and 10% on a year-over-year basis. Our continued operational excellence, sustained success of new product adoption, and cutting-edge technology is evidenced by our growth and strong margins. The end market for our hearing health products remains strong, and we're optimistic about our future. In Q3, Apple announced software updates that add over-the-counter hearing aid features to the AirPod Pro 2. Over-the-counter hearing aids address mild hearing loss, which is the least penetrated portion of the hearing health market. We believe these features will continue to drive hearing loss awareness as users will now have a hearing test readily available that could help them in understanding and recognizing hearing loss sooner. This, coupled with the potential of eliminating the stigma of using hearing health device, could drive earlier adoption of traditional hearing aids. Similar to previous years, we are expecting the MedTech and specialty audio segment to finish 2024 strong, with Q4 revenue being the highest of the year, driven by normal seasonality from new product launches within the hearing health market. Looking at our precision device segment, in spite of continued headwinds in inventory levels in the industrial markets, and with our distribution partners, revenue grew 6% sequentially driven by defense and electrification in markets. On a year-over-year basis, revenues grew 57% due to the acquisition of Cornell. I am also pleased with the progress we are making on expanding margins as we improve capacity utilization, productivity, and pricing. Reflecting on our ownership of Cornell this past year, I continue to be excited by this acquisition. We have improved our adjusted EBITDA margins 700 basis points throughout the year by accelerating cost synergies, continual operational improvements, and increased pricing. We have also instilled a disciplined approach to cash deployment leading to increased net operating cash flow. Despite continued challenges in our end markets, Cornell is expected to be accretive in its first year of ownership, a significant milestone, and a critical pillar in our acquisition strategy. As I look forward for the full precision device segment, we expect to see modest sequential revenue growth in Q4. While we have a very healthy pipeline of new opportunities in multiple end markets, which positions us well for growth as the market recovers in 2025, bookings continue to be inconsistent as we have yet to see a sustained recovery in the industrial end market and with our distribution partners. As I noted in the beginning of our call, I am pleased with the signing of the definitive agreement to sell the consumer MEMS microphone business. As already discussed, our quarterly results demonstrate our expanded margin profile as we continue to focus on more attractive growing end markets in the MedTech, defense, electrification, and industrial spaces. I am confident in our ability to deliver shareholder value as we complete this important step in our evolution to a leading industrial technology company. We expect the closing by the end of the fourth quarter and anticipate holding an investor forum in Q1 2025 where we will discuss our growth strategy and plans for the future in more detail. Now let me turn the call over to John to detail our quarter results and provide Q4 guidance. Thanks, Jeff. Please keep in mind all measures that I'll be referencing today are on a continuing operations basis and exclude the consumer MEMS microphone business unless specifically stated. We reported third quarter revenues of $143 million at the high end of the guidance range and up 32% from the year-ago period driven by the acquisition of Cornell in the fourth quarter of 2023 and organic growth of 4%. EPS was $0.26 in the quarter at the midpoint of our guidance range and up $0.06 or 30% from the third quarter of 2023. versus the prior year on higher demand in both hearing health and specialty audio. Gross margins were 53.1%, down 60 basis points versus the year-ago period, driven by unfavorable product mix and slightly lower production yields. The precision devices segment delivered revenues of $79 million, up 57% from the year-ago period, driven by the acquisition of Cornell, partially offset by lower shipments of high-performance capacitors into the distribution channel and to OEMs in the industrial end market as customer and channel inventories remain elevated. Shipments into the medical, defense, and electrification markets were up slightly and in line with expectations. Gross margins were 40%, down 40 basis points from the third quarter of 2023 due to the acquisition of Cornell, partially offset by a 230 basis point improvement in legacy PD margins driven by factory productivity gains. While gross margins at Cornell are below our legacy precision device business, we saw 500 basis point gross margin improvement since Q1 of this year, driven by improved factory capacity utilization, supply chain savings, and higher pricing. On a total company basis, R&D expense in the quarter was $8.9 million, up $1 million from Q3 2023 due to the acquisition of Cornell. SG&A expenses were $24 million, $5 million higher than prior year levels driven by the acquisition of Cornell, partially offset by restructuring actions taken in the second half of 2023 in the PD segment. Interest expense was up $3.3 million versus the prior year due to higher bank borrowings associated with the acquisition of Cornell in the fourth quarter of 2023. Now I'll turn to our ballot sheet and cash flow. In the third quarter, we generated $53 million in cash from operating activities above the high end of our guidance range on lower than expected net working capital and higher cash received from settlement of foreign exchange forward contracts. For the first nine months of 2024, we generated $95 million in operating cash flow, representing a $30 million increase over the first nine months of 2023. Please note that cash from operations for the three and nine months ended September 30 is inclusive of the consumer MEMS microphone business. Capital spending was 4 million in the quarter. During the third quarter, we repurchased 250,000 shares at a total cost of 4.5 million and reduced outstanding bank borrowings under our revolving credit facility by 38 million. We exited the quarter with cash of 93 million and $225 million of debt. That includes borrowings under our revolving credit facility and an interest-free seller note issued in connection with the Cornell acquisition. Lastly, our net leverage ratio based on trailing 12 months adjusted EBITDA was one times. Moving to our guidance. For the fourth quarter of 2024, revenues are expected to be between $141 and $151 million. of 5% versus the year-ago period driven by the acquisition of Cornell. R&D expenses are expected to be between 8 and 9 million, and selling and administrative expenses are expected to be within a range of 23 to 25 million, flat with the prior year. We're projecting adjusted EBIT margin for the quarter to be within a range of 21 to 23%. Interest expense in Q4 is estimated to be 3 million and includes non-cash imputed interest. We expect an effective tax rate of 9 to 13% for the quarter, which is lower than normal due to the utilization of foreign tax credits. We're projecting EPS to be within a range of 26 to 30 cents per share. This assumes weighted average shares outstanding during the quarter of 91.2 million on a fully diluted basis. We're projecting cash from operating activities to be within a range of 30 to 40 million, and capital spending is expected to be $6 million. Cash from operating activities includes $5 to $10 million used by discontinued operations, and capital spending includes $2 million related to discontinued operations. In summary, our third quarter results and fourth quarter guidance highlight the margin profile of our continuing operations. In addition, our increased exposure to attractive end markets, which include med tech, defense, electrification and industrials is expected to drive higher organic revenue growth rates which we will cover in more detail at our investor forum which is planned for q1 of 2025. i'll now turn the call back over to the operator for the q a portion of our call operator thank you if you have dialed in and would like to ask a question please press star followed by the number one on your telephone keypad to raise your hand and join the queue

To withdraw your question, please press star one a second time. If you have dialed in and are listening via loudspeaker on your device, please pick up your handset and ensure that your phone is not on mute when asking your question. Our first question comes from the line of Bob Labic with CJS. Please go ahead.

Good afternoon. Thanks for taking our questions and congratulations on the further transformation of the company. Thanks, Bob. Thanks, Bob. So I wanted to start with kind of the underlying demand in PD. And I know, I think, John, in your remarks, you talked a little bit about the end markets, but I wasn't typing fast enough. So maybe you could kind of remind us what you said and then tell us the driver. So what end markets in PD are the strongest right now and what's driving that and where is the weakness that you're seeing and when do you see that kind of recovering?

Let me just first give some color to this, Jeff. So I would sit there and say, generally speaking, the defense market still looks pretty okay. I think, obviously, along with defense, there has been and can be a time-to-time lumpiness relative to timing of orders, but the underlying demand is still there. And I think that's been a strength. I think we've definitely seen, especially when you think about our MedTech business in PD, but if you take it overall with the MSA business, our MedTech business continues to remain strong. I would say specifically in the PD area, we're starting to see the turn back to growth in MedTech in the PD section. I think MSA has still been doing very well, but MedTech is still growing. I think what I would sit there and say from my perspective is electrification you know, in two, three, two, four overall is probably flattish, you know, year over year. But the real weakness still remains in the industrial, and I would call with our distribution partners, which is a lot of industrial business. You know, and so that's kind of like the real weakness that we see is get yet. You know, I'd say, you know, I was with a number of our distributors who were actually visiting Knowles yesterday, and their commentary is, you know, kind of what we're seeing, which is, you know, one month bookings are good, next month they're a little weaker, then they come back. We're just not seeing yet in that portion of the market the consistency of bookings that we need to really see, you know, consistent year-over-year growth. Now, what I would say is, you know, I think we're still hopeful as we get into, you know, late Q1, Q2, we should start seeing some recovery. At least that's what some of our distribution partners are talking about. But I think the great thing is, in spite of all these things, the PD gross margin expanded through the year, and we expect there's opportunity for further expansion, first with the synergies and the things we're doing on the Cornell side, but also on capacity utilization relative to the traditional PD business that is not at Cornell.

Okay, great. I appreciate that very much. Obviously, with the transformation, you're going to probably be a little more asset light. And you may have told us this previously, but could you remind us the kind of go forward level of CapEx for kind of RemainCo?

Yeah, sure, Bob. I would say, you know, over a cycle, kind of 3% of revenue range, 3%. Yeah, I mean, I think if we had some expansion in an area, you could have a period where it's a little above that. But I think overall, over a cycle, 3% or over a cycle. And there could be a year where we're slightly lower, and then years where we're slightly over, but probably 2% to 4%, 2% to 4.5%, depending on where we are in the cycle. 2024 will probably likely be a little under the 3%. That's what I'm saying, correct.

Okay, got it. Great. And then last one, I'll jump back in queue here. But obviously, you know, this is kind of, you know, just the beginning, so to speak. Can you talk about the M&A environment, you know, for you right now and the characteristics of targets and, you know, how long it'll take you to kind of get back out and looking at things or, you know, what's out there now?

Yeah, I think it's a great question. Thanks for that. I think it's, you know, a core portion of our strategy going forward, you know, in terms of finding opportunities opportunities like Cornell where there's good synergies with what we do. I would say that we have a number of opportunities in front of us that we're assessing right now. I mean, it's always hard to say when that's going to come to fruition. We are going to be very selective in what we do. We don't want to do something that we come out into the street and think it doesn't make sense. So we're being very careful what we do. I would just add one thing that we are very pleased about, you know, that I think helps really the M&A story, which is, you know, it's very clear for us with all the transformation we've done into a higher margin business, our multiple is expanding. And I think that gives us more options relative to acquisitions. Our EBITDA multiple is expanding. And so it gives us more options with M&A. You know, and so to make things accrete much faster on a higher multiple Haviva dot basis. So I think this is very critical to our future, and we have a lot of resource being put into this. So, you know, well, I can't definitively say once something happens, we are on the hunt right now. I mean, we are looking.

Got it. Okay, super. Thanks so much.

Our next question comes from the line of Christopher Rowland with Susquehanna. Please go ahead.

Hey, guys, thanks for the question. I guess my first one is Cornell. That's pretty amazing margin expansion that you have there. I was wondering, do you still have continued opportunities? You know, I'd also love to focus a little bit on pricing there. Do you think you still have movement upwards in pricing? Is there something left here in terms of margin improvement that we could see for the CD business?

Let me handle the pricing first and then I'll let John talk just generally to the margins overall. If you remember when we went through this, I think And don't hold these exact numbers. When we first announced the deal, we didn't really talk too much about price. By the end of the first quarter of owner, we kind of talked about a couple million dollars of price. I think last quarter I talked about three to four million of price. I think we're going to be, for the year, above $5 million of price that we're going to get this year. And, you know, if you look at the timing of price, you know, we have longer-term contracts with customers. There's a lot of inventory in the channel relative to the industrials. So there's going to be, based on the pricing actions we've already taken, there's going to be more price in 2025. So I would say $5 million this year, maybe another couple million next. So a big portion of the margin improvement is coming from price. I'd say the second thing, and John can kind of expand on this, but we really haven't done a tremendous amount yet on what I call value creation on the manufacturing floors with Cornell. That process will take the start of next year. We'll start working on that. We'll start laying that out. But I think there's also opportunity to do the things that we do in the traditional NOLS business, whether it be PD or the MSA business, where we get a fair amount of value creation every single year. So I would say I'm reasonably confident that we're going to have more margin expansion. And we'll talk more about the investor day, kind of overall for the PD segment, what kind of margin expansion that we can get. But we should get more from Cornell. I don't know, John, do you have any other comments? I think just to kind of reiterate what Jeff said, we had 500 basis points of improvement in Cornell, and it was really driven by improved pricing. Also, to a lesser extent, we're getting some supply chain savings, material savings. So that's there. I think that will continue into 2025. then also we're planning on getting the major sites on our oracle instance once we get that there's some also i'll call it opex synergies to harvest from that so there's room for for increased margin in that corner yeah i think what i just would kind of highlight here is the last thing on the price because obviously you know this has been a relatively challenging year for the pp segment as a whole in terms of revenue especially the industrial market And we're still getting $5 million of price in the year. And I think that bodes really well as the market recovers, what it means.

Thank you, Jeff. And, yeah, I did, as a lead-in, want to talk a little bit more about industrial issues. So it sounds like there might be some inventory there. Would love to know when you think that normalizes, how much inventory is there. And then if you could break this up into, you know, what you're seeing geographically, like east versus west. I know there's a debate over EVs, for example. China EVs look good. West EVs look a little soft. and anything like that would be helpful.

Yeah, so I think our best indicator, quite frankly, of inventory, it's really hard with – a little harder with OEMs or direct customers to really know the exact amount of inventory. But with our distribution partners, we have a pretty good view into the inventory that they have. We still believe, based on the data they're reporting to us, that our distribution has about – six months worth of inventory on hand right now. In order to really get back to normal ordering patterns, that's still got to come down by about three months. Now, you know, when that happens, again, as I kind of said on the earlier question, you know, when you meet our distributor partners, they say one month's good, one month's poor. It's been inconsistent, right? It hasn't been all just totally horrible, but it's been inconsistent. And, you know, I would say it's This is primarily North America and Europe. There isn't as much business in our PD segment in the industrial markets in Asia. It's not as much. And specific to electrification, now that's really not China, but we do have Asian customers. We are not doing a tremendous amount of electrification in China. I would say we're doing, and that, again, right now in the back half of the year, you know, looking at this, It's flattish year over year in terms of, because what I say is, yes, the electrification market is weak, as you kind of pointed out, but we also have new design wins going into production. We are garnering new opportunities that are starting production. So that's kind of offsetting being down in electrification, even though we're not participating as heavily in China. Awesome. Thank you.

Again, if you would like to ask a question, please press star one. Our next question comes from the line of Tristan Guerra with Baird. Please go ahead.

Hi, good afternoon. Looking at the macro environment, and you highlighted the continued weakness in industrial, the first question is, have you seen in other end markets, including consumer, any changes in demand patterns over the past few months, or is it stable? And also, if you could talk about pricing, excluding the impressive progress you're making at Cornell. Are you seeing any unusual pricing changes in the high-end capacitors? What are you hearing from your customers as you perhaps renegotiate some annual pricing contracts there?

Yeah. So, first, I'll just make a comment. Obviously, we've moved the CMM business into discontinued apps, and that's our exposure to consumer until obviously that is fully sold. That is in line with our expectation going into the quarter, you know, and as I look even into Q4, it's running in line with expectation. I think it's doing fine. You know, so I think there aren't any big issues we see in consumer at this moment. Now, yes, about the pricing environment within, first within MSA, you know, I would say stable. That's what I would say. We're not seeing a tremendous amount of pricing increases, but we're not seeing pricing reductions either that are pointing to any issues. And then in PD, which is primarily ceramic capacitors, which is a lot of end markets, and then RF, which is primarily defense, I would actually say in defense, there is, we still think, some opportunity in terms of price in the RF market going forward. And then in the traditional cap space, I would say it's stable. I think one of the benefits we have in our businesses is that a big portion of our businesses in PD is sole source positions. And so I think we're in long-term contracts with a lot of people, and we don't see a tremendous amount of price pressure in these markets, even in a down market.

great that that's great to hear and then um how should we be looking at uh this coming quarter uh as you know the the sequential trends for the various end market within the pd yeah okay uh let me think i think we'll look at these um on a sequential basis you know we're expecting um but first let me say for pd overall you know i kind of said on the prepared remarks

We're expecting modest sequential growth, right? You know, and so, you know, if I look at the end markets overall, the fence is going to be up. Medtech is going to be up. Electrification is flat and industrial is flat, right? You know, so, so, you know, again, you know, back to my kind of points about industrial and distribution, which is a lot of industrial customers. It's not like we're seeing a degradation sequentially, but obviously these numbers were running a lot higher if you go back a year and a half ago. So we're just not seeing the continued improvement that we kind of saw. We did see some improvement from Q2 to Q3 in the industrial market, but that's kind of like now back to flat sequentially from Q3 to Q4. Great.

Thank you very much.

There are no further questions at this time. This will conclude today's conference call. Thank you all for your participation. You may now disconnect.